By:Martin CrutsingerThe Associated Press, Published on Wed May 01 2013

WASHINGTON—The U.S. Federal Reserve on Wednesday stood by its aggressive efforts to stimulate the economy and reduce unemployment. And it sent its most explicit signal to date that tax increases and spending cuts that kicked in this year are slowing the economy.

“Fiscal policy is restraining economic growth,” the Fed said in a statement after a two-day policy meeting.

The Fed maintained its plan to keep short-term interest rates at record lows at least until unemployment falls to 6.5 per cent. And it said it will continue to buy $85 billion (U.S.) a month in Treasury and mortgage bonds. The bond purchases are intended to keep long-term borrowing costs down and encourage borrowing and spending.

In its statement, the Fed made clear that it could increase or decrease its bond purchases depending on the performance of the job market and inflation.

David Jones, chief economist at DMJ Advisors, said that in saying it could increase or decrease its bond purchases, the Fed wants to show its flexibility: It’s ready to respond, whether the economy improves or weakens significantly.

“I think the Fed is in a wait-and-see mode, like the rest of us,” Jones said.

Jones said he expects no change in the level of bond purchases until September or later this year. The Fed wants time to see whether the economy can grow fast enough to drive sustained improvement in the job market, Jones said.

Debate among Fed policymakers at the March meeting had prompted some economists to speculate that the Fed might scale back its bond purchases if job growth accelerated.

But several reports in recent weeks have signalled that the U.S. economy has weakened since the start of the year. Employers added only 88,000 jobs in March, far fewer than the 220,000 averaged in the previous four months. And the economy grew at an annual rate of 2.5 per cent in the January-March quarter — a decent growth rate but one that’s expected to weaken in coming months because of federal spending cuts and higher Social Security taxes.

At the same time, consumer inflation as measured by the gauge the Fed most closely monitors remains well below its 2 per cent target. That gauge rose just 1 per cent in the 12 months that ended in March.

The Fed has been joined by other major central banks in seeking to strengthen growth and reduce high unemployment.

The European Central Bank could cut its benchmark lending rate from a record low of 0.75 as soon as Thursday because the euro area’s economy remains stagnant.

Unemployment for the eurozone is 12.1 per cent. And the ECB predicts that the euro economy will shrink 0.5 per cent in 2013.

Japan’s central bank has acted to flood its financial system with more money to try to raise consumer prices, encourage borrowing and help pull the world’s third-largest economy out of a prolonged slump. Economists say Japanese consumers will spend more if they know prices are going to rise.

The Bank of Japan has kept its benchmark rate between 0 and 0.1 per cent to try to stimulate borrowing and spending.

The Fed’s goal is to keep price changes from hurting the economy. This could occur if inflation raged out of control or if the opposite problem — deflation — emerged. Deflation is a prolonged drop in wages, prices and the value of assets like stocks and houses.

The United States last suffered serious deflation during the Great Depression of the 1930s, but Fed policymakers worry more about the threat of deflation any time prices go lower than 2 per cent.

The Fed’s action Wednesday was supported on an 11-1 vote. Esther George, president of the Kansas City regional Fed bank, dissented for a third straight meeting. The statement said George remained concern that the Fed’s aggressive stimulus could heighten the risk of inflation and financial instability.

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